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Telstra sees light through the cloud

Telstra's Asian network has had a chequered history, but the telco still has its eye on growth. Building up its regional cloud computing infrastructure is the new focus for chief executive David Thodey.

It is ironic that out of one of the darker and most misunderstood chapters in Telstra’s modern history has emerged one of the more interesting growth options in its post-NBN future.

In David Thodey’s KGB Interview he described Telstra’s international assets – its undersea cables and its satellites – as one of the best international networks in Asia.

"The fascinating thing that’s happening in international connectivity is that people are using it more and more for both data and voice," he said.

Telstra is investing about $650 million, and Thodey expressed a willingness to invest more if the returns justify it, in adding value to that network. It has built cloud computing infrastructure in Australia and plans to build similar facilities in Singapore and Hong Kong to leverage its infrastructure and build what Thodey hopes will be a multi-billion-dollar growth business.

Those international assets have had a chequered history. Telstra took control of them when the old Telecom was merged with OTC in 1992 in that period when the group was being corporatised and prepared for its eventual privatisation. OTC itself had been created in the immediate post-War period on a base of assets acquired from AWA and Britain’s Cable & Wireless so Telstra and its predecessor entities have had a very long and substantial presence in the region.

In 2000, as the ‘dot-com’ bubble reached its peak, former chief executive Ziggy Switkowski struck a deal with Hong Kong entrepreneur Richard Li’s PCCW group to merge their cable and satellite assets in the region to form the Reach joint venture to exploit an expected explosion in demand for international capacity.

Unhappily, others (notably WorldCom, a bubble phenomenon whose collapse in 2002 was then the biggest in US history) had the same idea and there was a dramatic increase in capacity just before the bubble imploded – and severe over-capacity and plunging prices after it burst.

The Reach joint venture plunged into losses and Telstra was forced into a $1 billion writedown. Reach was restructured and its banks, which had lent on a non-recourse basis, were forced to take a ’haircut’ of almost $US900 million.

It wasn’t a happy episode in Telstra’s history but in fact it wasn’t as bad as it appeared. Telstra gained its equity in the joint venture by vending in its assets, which had a book value of about $700 million. To equalise the joint venture interests it extracted $700 million of cash – effectively it had a free carried interest in Reach. The subsequent write-down represented a write-down of the bubble-inflated values attributed to Telstra’s assets in 2001.

Last year Telstra and PCCW restructured Reach again, dividing up the assets between them and giving Telstra 100 per cent ownership of the core assets and well as management of the residual jointly-owned assets. That has created a clean platform for Telstra to invest and add value to the network.

In the post-NBN environment (whether it is Stephen Conroy’s version of an NBN or Malcolm Turnbull) Telstra will effectively have big annuity income streams flowing from its old copper network. While there is a lot of cash and value latent in those income streams there won’t be much growth.

The ’new’ Telstra will have its wireless network and the retail margin from the customers it can retain during the migration off copper to a fibre-dominated network operated by NBN Co, as well as some value added income streams from the applications and services and content it can sell those customers.

There isn’t much of significance Telstra would be allowed to buy in Australia that it would want to buy – Thodey appears much more interested in investing in adding value to Telstra’s core commodity business of providing capacity for voice and data than large-scale diversification by acquisition here or offshore.

If it is to create growth businesses to replace the longterm diminution of its high-margin domestic commodity revenues it will almost certainly have to do meaningful things offshore, whether by acquisition or organic investment.

Thanks to its history Telstra has one of the handful of extensive cable and satellite networks in a region where the demand for telecommunications capacity and services should grow dramatically over the next few decades (AT&T and Japan’s NTT are also significant players in the region).

Those networks provide Telstra with what should be material growth in its basic commodity business of selling capacity but also value-adding growth opportunities from building cloud computing infrastructure and offering applications to customers within the region.

At a time when its rivals in the US and Europe are somewhat pre-occupied with their domestic conditions, it doesn’t hurt that Telstra has, courtesy of the taxpayer, a guaranteed $11 billion war chest (in net present value terms) that it can deploy over time to build its position and offering and create a growth dimension for the company in the longer term.

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